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The American dream has never been easy to define with precision, but if current television is any indication, it has something to do with housing. Scores of shows appeal to viewers’ home-improvement fantasies (Extreme Makeover: Home Edition), interior-design aesthetics (Trading Spaces and Cribs), and profit motives (Designed to Sell). “Property flipping,” it seems, has replaced “tech stock” as the talismanic phrase embodying Americans’ financial hopes. According to a National Association of Realtors study, 23 percent of all homes bought in 2004 were bought not as residences but as investments.

Is this evidence that we are in a real-estate bubble? The chart below—created by the Yale economist Robert Shiller for the second edition of his book Irrational Exuberance—suggests that we are. An index of U.S. home prices since 1890, it controls for factors that cause people to overestimate returns on home purchases: home improvements, increases in average house size, and inflation. In other words, it shows the real appreciation of a standard, unchanging house over time.

The chart plainly shows that—contrary to conventional wisdom—real estate has generally not been a road to riches. From 1890 to 2004 real home values rose by an average of only 0.4 percent a year. The chart also shows that the current boom—in which real housing prices increased by 52 percent from 1997 to 2004—is almost unprecedented historically. Only the period after World War II—when legions of GIs came home to government housing subsidies—is comparable.

So what accounts for the boom? Low interest rates, expanded credit availability, and a reallocation of spending from travel to housing after 9/11 are all factors. But low interest rates can support high home values only as long as they stay low, and none of these factors can fully account for the run-up in prices. It appears that residential real estate in the United States is simply overvalued today.

That said, real-estate markets are famously local. The Single-Family Housing Monitor, a report published by the research firm Economy.com, analyzes home-price imbalances in 142 metropolitan areas, comparing actual prices with what the regional market should be able to bear based on personal income, interest rates, construction costs, and housing supply. According to this model, housing was overvalued by an average of 21 percent in 2004 in the areas studied—more than in any other year since 1988, which is as far back as Economy.com has looked. But that figure is largely the result of moderate or severe overvaluation in many of America’s largest cities. Overall, only about 40 percent of the metro areas evaluated by Economy.com appear overpriced.

[Click here to view a larger version of the map above.]

The overvalued markets tend to cluster on the coasts, where land for new construction is limited and evidence of portfolio-shifting from stocks to housing is strongest. The country’s interior (Las Vegas being a major exception) seems less prone to bubbles, in part because new homes can be built easily and profitably whenever speculative pressures build.

Real-estate bubbles across the country could burst suddenly, particularly if some large crisis—such as a major oil shock or a run on the dollar—were to rattle the economy first. But for the most part real-estate bubbles tend not to burst abruptly, like stock-market bubbles; rather, they deflate slowly, over years. That’s partly because when prices begin to decline, many people refuse to sell their homes, thereby restricting the supply of housing and arresting the decline in prices.

So does that mean we can relax about these record-setting real-estate overvaluations? Not necessarily. If history is any guide, once home prices begin to falter, they are likely to decline or stay flat for many years. The resulting falloff in construction and in home-equity-based spending will hurt the economy. But the greater damage may be to America’s sense of itself as upwardly mobile—or as mobile, period. Many people, unwilling to sell at a loss, will feel stuck in homes that no longer suit them, in communities they want to leave. And the notion that our shelters can act as substitutes for saving, as ATMs for our vacations and forays into luxury living, as (self-financing) vehicles for our aesthetic impulses, will be punctured. We have become accustomed to treating our homes as tickets to financial freedom. Ultimately, that may be too much to ask.